Hybrid DC ruling prompts review of safety nets

The Supreme Court has voted four-to-one for some defined benefit (DB) features of defined contribution (DC) schemes to be designated as money purchase, meaning they are not subject to the government's scheme funding regime.

This also means benefits such as internal annuitisation and guaranteed DB underpins are not within the remit of the Pension Protection Fund (PPF) to compensate members where the scheme has fallen into deficit in these areas.

Schemes have been urged to consider the funding requirements and protection for the different benefits they offer.

While the government has signalled its intention to use primary legislation to reverse at least parts of these judgements, schemes should include any impact of the judgment on their provision in a member newsletter.

They should make a value-for-money judgement on whether those protections such as the PPF would be worth pursuing, once the legislative dust has settled, and question how the costs could be divided among members.

Setting precedents

The original 2006 case centred on the construction of the Imperial Home Décor Pension Scheme, whose sponsor had gone into administration, and the scheme was in the process of winding up.

The government intervened in the case, appealing against certain benefits such an internal annuitisation being classed as DC, especially where a deficit can be built up.

Zoe Lynch, a partner at Sackers, said the judgment, which found all these benefits should be classed as money purchase, was “fantastically important” to affected schemes.

She said: “It can make the difference as to whether your benefits go into the PPF if your employer becomes insolvent.”

The PPF will generally pay 90% of the level of compensation to the majority of people below their scheme’s normal retirement age, and 100% to those above.

The government said the case – a loss for the Department for Work and Pensions (DWP) – would lead to schemes being regarded as money purchase while remaining at a risk of funding deficits.

It said in a statement: “This will place some schemes outside the scope of a wide range of legislation, including that governing scheme funding, employer debt, the Pension Protection Fund and the Financial Assistance Scheme.”

It will create a lot of uncertainty as to how trustees will distribute the assets of the scheme if it had to wind up, prompting the DWP to introduce retrospective legislation to "ensure appropriate protection" for member benefits.

The statement continued: “Our intention is that the legislation will have retrospective effect at least from the date of the judgment, and will make it clear that benefits cannot be regarded as money purchase benefits if it is possible for a funding deficit to arise in respect of any of those benefits.”

Lesley Browning, a partner at Norton Rose, said schemes should already have considered what protections their members' benefits have under the 2004 legislation that brought the PPF into existence.

She said: "You might have a scheme that only has internal annuitisation for some of the members. You have to think any increased protection that those schemes would get through the 2004 regime would come at increased cost."

PPF protection means a cost to a scheme in terms of the levy, and its management would face a difficult choice about how to apportion that charge across the membership, which could have a different share of these defined benefit style benefits.

But schemes have been advised not go overboard in terms of the communication around this case, in light of the DWP's firm comments on amending legislation.

Browning added: "I suggest you put it in a newsletter and try and explain it a bit. I wouldn't send out a bespoke communication."

A boost for collective DC

Robin Ellison, a partner at Pinsent Masons and advocate of collective DC, said the judgement was encouraging for the growth of this form of workplace saving.

He said: “If certain kinds of DC were regarded as defined benefit, then the whole panoply of the funding requirements and compliance would sink them. You would not do collective DC.

“The DWP have a few reservations about it which this case hopefully clears up.”